Don’t worry about a thing,
‘Cause every little thing gonna be all right
Bob Marley, Three Little Birds
The past few weeks have given us a steady parade of top investors speaking at conferences. From the highly entertaining panel at Milken featuring Steve Cohen, Cliff Asness and Neil Chriss (see the whole discussion here), to the somewhat disappointing Ira Sohn conference to the recently concluded SALT extravaganza, we’ve gotten a hit parade of downbeat hedge fund managers lamenting the fate of their chosen profession (full disclosure: I’m a hedge fund manager too). Apparently, managing money is hard. Especially when you get too big to be flexible. Why this is new news isn’t clear to me, but apparently it’s a bit of a surprise to all those who allocated money to the top 10 or 20 funds. Size is the enemy of performance. Any manager who tells you differently is either a fool or lying. Not sure either is good. But smaller managers who remain flexible in their net exposures and can move in and out of positions without moving the markets should still be able to perform well over a full cycle. And I think we’re getting near the end of the bull run in this one.
At SALT, Leon Cooperman said he wasn’t sure it was worthwhile managing outside money anymore. At Sohn, Stanley Druckenmiller said to get out of all equities. I feel like I’m experiencing a weird sense of de ja vu. Because these same guys were saying the same things in late 1999 and early 2000. Also back then, Julian Robertson famously gave up fighting the internet bubble and threw in the towel on managing money (a terrible bet on US Air didn’t help things either). At that time, the market was doing irrational things for longer than the hedge fund community could take it. Sound familiar? It does to me. And then the bubble burst, hedged strategies proved their worth, and hedge funds that were positioned defensively enjoyed a great 5 year run. I know we did – we had great performance in 2000, 2001 and 2002, while the “market” struggled. I think we’re heading for a repeat performance. The overall market is due for a steep fall, but managers positioned properly can make good money both long and short in the next few years. So don’t worry about a thing.
Real long-short hedge funds, not the highly-concentrated private-equity-like things that folks like Bill Ackman run, will do well in coming years. Long-short funds have had a tough run, and the press is full of stories about the pension plans run by California and New York City pulling out billions of dollars because the performance hasn’t been good lately. To me, these large pension plans are the perfect contra-indicators. The U.S. stock market is sitting right under its all time high, and now the pension plans want to go bigger in long-only index funds? Wow, it is late 1999 all over again. Hedging doesn’t look so good when the market goes up for 6 years. But how good will indexing look when the market is flat-to-down for 5 years or more? Not so good. And then I bet that these same sheep, ah, pension funds, will come running back to chase performance in hedge funds again. Probably at a market bottom.
Rise up this mornin',
Smiled with the risin' sun,
Three little birds
Pitch by my doorstep
Singin' sweet songs
Of melodies pure and true,
Sayin', "This is my message to you-ou-ou "
Bob Marley, Three Little Birds
Why do I think that the stock market in the U.S. is heading for a fall? There are a number of reasons, none of which on their own will tip it over, but which in combination will make it harder for the market to continue its rise. So here is my message to you:
Stock and bond valuations are both very high. On a number of metrics, we’ve almost never been higher. And when were stocks higher? 1929, and early 2000. If growth was strong, earnings were going higher for most sectors, and rates were benign, then we’d have some room to move up in the markets despite the high-valuations. But growth isn’t strong (revenue growth is hard to find – just look at the retailers this past week), earnings are down year-over-year, and rates are just weird. Every time the Fed mentions raising them, the markets throws a fit. Not a good setup when rates are too low for the financial markets to effectively allocate capital and the banking system to function well. Rates should be higher in the U.S. (and around the world), but the Fed is afraid of its own shadow, so it does nothing, as we’ve discussed many times before.
Geopolitics are not great. The Middle East is a mess, but this somehow has moved from the front pages despite “issues” in Syria, Iraq, Yemen, Lebanon, Egypt, Libya, etc. Oh, and the refugee crisis -- it’s still ongoing, in case you forgot. Europe is facing a crisis in its banking system, its political union, and its economy, all without the will to jump-start their economies through infrastructure spending and labor reforms. It is a slow motion train wreck, and won’t get better any time soon.
And then there is China. Forget about its militarization of the seas around it, and the personality cult that Xi is creating around himself. Now we have The People’s Daily, the mouthpiece paper of the ruling Communist Party, publishing a piece on May 9th quoting a leading party official who is warning of significant problems, including a bubble in real estate, industrial overcapacity, rising debt and non-performing loans, among other issues. We have been harping on these issues in China for a long-time, as have others, such as Kyle Bass and George Soros. So to see the official paper actually admit that these issues are real and a problem for growth there going forward was quite shocking, since up to now the government has resolutely stated that “there is nothing to see here.” Well, apparently now there is. Pay attention.
Here in the U.S. things are getting weird too. We have the bizarre story from last week about how the Obama administration played the media for fools in order to get his Iran deal passed. It’s a crazy read. Then we have the ongoing circus around the nominations for both parties. Sanders keeps winning, but Clinton doesn’t seem to notice. So now Sanders is threatening a contested convention on the Democratic side, in addition to the potential for fireworks at the Republican convention (while the other candidates besides Trump have “suspended” their campaigns, there is still the strong likelihood of a failed first ballot and then chaos on the second). This should be interesting.
Which would all be fine if stocks were cheap and the biggest companies were doing well. But they aren’t. For example, Apple continues to fall apart. As we wrote back on November 3rd, 2015, when the stock was at $122.57 (self-congratulations: it hasn’t traded higher since then), Apple faces a host of issues, from its declining sales for its iPhones to its lack of a new category killer. Now it will be facing a hostile Chinese government if it doesn’t agree to provide the government with access to the data on its phones. So the company is stuck. By refusing to give the FBI access to data on iPhones in the U.S., it has set itself up for failure with the same policy in China. Refuse and they are out. Capitulate and they lose the “victory” they claimed in the FBI fight. This is myopic strategic thinking and hubris at its worst. After it blows up, Apple might be a buy. But until then, it’s uninvestable, even here at $90, although it is due for a trading bounce.
This week’s Trading Rules:
- (Quoting Dr. Rudi Dornbusch) The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought possible.
- When you see smart fund managers talking about going out of business for being too conservative, the end of the bull market is near. Play smaller and get defensive.
Stocks continued to follow our playbook the past 2 weeks in the U.S., as smaller stocks performed better than large cap and the SPY struggled twice at the 208 level. Nothing has really changed. Right-size positions and get ready to play more active defense. Macro issues have been quiet – too quiet. My sense is that the big move since February will continue rolling over. As Art Cashin would say, be wary and very, very nimble (yes, we quoted him last time). Because the crisis can happen faster than you would think is possible.
SPY Trading Levels: The market is still coloring within the lines. The SPY stopped right at the 209/210 resistance we mentioned last time as being a tough level to get through. Moving a lot higher will be hard, and I think we’re headed lower near-term, but if we do break 211, expect a sharp spike as shorts rush to cover and cautious investors play catch-up.
Support: 204/205, a little at 200 and 195, then 185
Resistance: A lot at 208, 209/210, 213, then not much.
Positions: Long and short U.S. stocks, ETFs and options. Very hedged against a large decline.
Miller’s Market Musings is a free bi-weekly market commentary written by Jeffrey Miller, who has been managing money through various market environments for over 20 years. You can subscribe here. If you no longer wish to receive this letter, simply hit reply and put “Remove” in the subject line. Prior posts can be found at www.millersmusings.com.
Mr. Miller has been quoted in financial publications including the Wall Street Journal and New York Times, and he has appeared on Fox Business News, PBS and CNBC. More information and past articles can be found at www.StockResearch.net. Sharing and quoting from this letter is permitted with attribution.